Slowly but surely, India hedge funds are beginning to offer the kind of strategies that can attract big fish such as London hedge fund giant Man Group, whose fund of hedge funds business could make its first direct allocation to an Indian hedge fund within a year, according to Asia business head Patric Gysin.

The entire Indian hedge fund universe is modest at around 50-60 funds. When that universe is boiled down to reveal those funds sophisticated enough to attract larger institutions and marquee fund of hedge funds (FoHF) investment from Europe or the US, it could more appropriately be described as a small planetary system – if one was feeling generous.

The $15bn FoHF portfolio of London-based hedge fund giant Man Group, for example, is 10-15% exposed to emerging markets and 1% exposed to India. None of the latter exposure is achieved through direct investment into dedicated India-based hedge funds, but rather via the firm’s global emerging markets or pan-Asia funds, which then allocate a variable portion of their pot to Indian securities.

However, according the firm’s Asia business head and senior portfolio advisor Patric Gysin, this is likely to change. Indeed, encouraging signs of life at the more liquid end of the Indian hedge fund market mean Man could realistically make its first direct investment into an India hedge fund within a year, he says.

Currently the firm is working closely with around ten India-based hedge funds – around half a dozen of which Gysin describes as “really serious India hedge funds with a track record and a mandate which suits our needs”, and the remainder, which are recently launched funds offering encouraging new levels of flexibility in their approach.Typically, India-based hedge funds are relatively risk-averse and illiquid equity funds, which fall somewhat short of the highly liquid, short-selling, alpha-generating strategies synonymous with the ‘hedge fund’ tag. Strategies which can help alleviate the volatility inherent in emerging markets, Gysin says.

“The India hedge fund universe is fairly limited. There aren’t many liquid India strategies,” he says, noting that the lack of shorting tools available in the Indian market has held its evolution back. “Hedging has been more difficult in India than most Asian markets, which hasn’t helped. We are looking at maybe half a dozen liquid long/short India hedge fund managers. If we look at mandate and market structure and tick those boxes, that leaves a really small selection, which is why we don’t have a dedicated India manager.”

But a recent uptick in the launch of more nimble India-based hedge funds – predominantly from within Asia as opposed to the West – suggest that the hedge fund industry is becoming more aligned to the requirements of sophisticated investors like Man.

“There have been some promising hedge fund launches in the region,” says Gysin, who declined to name individual fund managers. “We have come across some interesting managers who have launched liquid strategies in the last two years, which is encouraging. What we’ve seen in the last six months or so leads us to believe we will have a dedicated India exposure in the next 12 months.”

According to Gysin, many of the existing 50-60 India-based hedge funds focus on small/mid-cap, Private Investment in Public Equity (Pipe) and pre-IPO investments as their staple diet. “This doesn’t fit with what we are looking for,” he says. Indeed, the theme of manager flexibility is paramount to Man’s emerging market fund selection process, and the firm broadly avoids the “small, illiquid names” investing in these kinds of transactions.

“There is nothing wrong with Pipe transactions but you need a longer term investment horizon, incorporating three-year lock-ups. Many funds out there are static,” he says. “We feel more comfortable with more liquid investors in emerging markets such as India; if things go wrong, which they regularly do in these markets, liquid managers are able to reduce their positions fairly quickly.”

According to Gysin, Man’s underlying managers have in common a flexible approach in terms of how much market risk their funds can take – some often operating as low as 10-20% net long, and sometimes even net short if necessary.

“[These managers] have proved they can really reduce market risk and take on market risk as well. We think having this flexibility is important in investing in emerging markets – those are volatile growth markets, so we think it is reasonable to have market exposure but to take a flexible approach to managing this exposure,” he says. “When these managers think there is a storm on the horizon, they really reduce the exposure and risk in the portfolio, and on the other hand, when they think things are improving, they can take more risk.”

If Man does eventually add an India-focused fund to its approved list, investment into the fund is most likely to be done via one of the firm’s diversified long/short emerging market or pan-Asian funds, which have remits that allow them to invest in a large number of managers, Gysin says. The firm runs a wide range of products – some of which have limitations on the number of funds they can invest in, and are more likely to invest in regional hedge funds rather than country-specific offerings, he adds.

While Gysin notes that there are certain areas of the India market which he thinks need to improve in order to encourage Indian hedge fund activity – mainly revolving around ease of access and investment flexibility – equities will continue to present the best strategy for India-based hedge funds, and long/short equity investing will continue to form the basis of Man’s Indian hedge fund exposure.

“India is pretty much an equity story. Hedge funds can only be as liquid as the underlying market; if the markets are drying up, so do hedge fund investors. The India equity market is fairly developed for local investors, and I would expect equities to be the most interesting way to capture upside,” Gysin says.

“But to encourage the Indian hedge fund industry to grow, the regulations for shorting stocks have to improve – it’s a headache for offshore managers investing in India through Mauritius entities. Whatever the regulators can do to ease market access for hedge funds will be positive for the markets – if the market has hedge fund participation, it increases liquidity and helps pricing mechanisms,” he adds.

“India is still a challenging market to get exposure to,” Gysin says, noting that while a massive institution like Man has the global resources to conduct thorough research and get close to the Indian market, smaller firms without a presence in the region will continue to find this difficult.

However, despite the challenges, the Indian bourse continues to appeal, and as India’s economic story unfolds it looks increasing likely that Man will find an India-based hedge fund that ticks all the boxes. Indeed, even without allocation to a dedicated India manager, Man’s exposure to Indian securities has increased via its regional funds, Gysin says, and the firm’s long-term outlook for the market is very positive.

“Our exposure to India has increased in the last couple of months; the elections were important in order to get some clarity around the future of government, ongoing reforms and the expected reduction of India’s fiscal deficit, which is all perceived as good news and we feel more comfortable in taking positions in India,” he says. “Last year people considered the Indian market to be way too expensive, but the market has corrected somewhat, which has changed opinions a little, and more managers started to increase their Indian exposure over the last couple of months.”

However, some caution still remains among Man’s investors. “People are still worried – the biggest concerns I hear are over inflation,” says Gysin. “Oil price is also a big risk to the Indian economy for obvious reasons, and the other risk I still hear is the geo-political risk regarding Pakistan. But over the medium term we have a positive view – especially with reform, privatisation and infrastructure shaping up.”

Moreover, Gysin thinks hedge funds are the best vehicles through which to maximise the phenomenal growth on offer in India’s huge, rapidly growing but relatively turbulent economy. “More than 40% of India’s population is below 20 years old, which points to very strong demographic trends. The workforce is well educated and developed, and the ingredients are there for this to become a longer term success story. Long term, we are not worried by being long on India,” he says. “But that comes with volatility, which is why we think a hedge fund strategy which can reduce downside considerably while participating in upside is the most appropriate strategy with which to approach India, and other emerging markets.”

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